What do S&P 500 stocks tell investors about the market? (2023)

The S&P 500 is one of the most traded stock indexes in the world, representing a large portion of America's most prominent publicly traded companies.

Unlike the heavyweight Dow Jones Industrial Average (DJIA) or NASDAQ, the S&P 500 is often considered a proxy for the United States economy, as it is a broad index that covers every sector and industry on the stock market.

In this article, you'll learn how to invest in the S&P 500, who determines its composition, and why it's considered the best benchmark for the overall US economy.

A brief history of the S&P 500

Stock indexes have been around for over a hundred years, but the S&P 500 is relatively new compared to the Dow Jones Industrial Average (DJIA) or the Dow Jones Transportation Average (DJT). In addition, the older Dow Jones indexes contain only a few companies and are often considered inadequate when used as a proxy for the overall economy.

Iterations of the S&P 500 have existed since the 1920s, but today's version arrived on the scene in 1957. Called the S&P 500 Composite Index, it did not contain 30 companies like the DJIA, but 500 companies to better represent the entire economy. Theshares in the indexthey are also adjusted more often because the reconstructions are quarterly. Note that the index is the 500 largest US-based companies, not 500 stocks - more on that later.

Additionally, the S&P 500 is weighted by a company's market capitalization rather than a stock price like the Dow.Market capitalization weightingis usually the best methodology since company capitalization is usually more stable than stock prices. At the end of 2022, the total value of S&P 500 stocks was almost $34 trillion.

Why is the S&P 500 important?

The S&P 500, often referred to as the "benchmark," is the benchmark against which most institutional investors and fund managers compare themselves. And while not all major US companies are included, the S&P 500 is the closest representation of the US economy that the markets have built. It is broad and includes companies fromall market sectorsand regions in the US.

Not only is the S&P 500 the best market proxy for the economy, it's also one of the easiest indexes to invest in through various mutual funds and derivatives. Index funds that track the S&P are some of the cheapest funds on the market and have plenty of liquidity for frequent traders. Additionally, most US pension funds are held in vehicles based on some version of the S&P 500 index.

Requirements for listing a company on the S&P 500

Unlike most major stock indexes, the S&P 500 is actively managed. Quarterly, the committee meets to update all additions and removals from the index, along with any changes to listing requirements. For example, the commissionmet in June 2021increase the purchase capital limit for acceptance. Here's what a company must have to be included in the S&P 500:

  • Minimum purchase price of $13.1 billion
  • Monthly trading volume of 250,000 for at least the last six months
  • Must be based in the United States
  • It must be publicly traded on a major US stock exchange such as the NYSE or NASDAQ
  • It must maintain an average share price of at least 75 cents

In addition, securities such as limited partnerships, over-the-counter stocks, mutual funds or ETFs, preferred stocks and stock options are automatically excluded from the index.

Example of an S&P 500 stock

Because the S&P 500 index is weighted by market capitalization, the largest companies have the greatest influence on the overall direction. So if you want to see the bigger picture, just look at the US large-cap stocks that underpin so many portfolios:Apple Inc. (NASDAQ: AAPL),Microsoft Corp. (NASDAQ: MSFT),Alphabet Inc. (NASDAQ: GOOG)iAmazon Inc. (NASDAQ: AMZN).

As mentioned above, the S&P 500 is the 500 largest companies, not the 500 largest stocks. The S&P 500 typically has more than 500 stocks at any given time. Additionally, market cap-weighted companies with multiple share classes such as Alphabet,News Corp. (NASDAQ: NWS),Fox Corp. (NASDAQ: FOX)and earlierUnder Armour Inc. (NYSE: UAA)will have both stocks listed in the index, not just one. So far, the S&P 500 has 503 stocks in the index.

The new component of the S&P 500 isFair Isaac Corp. (NYSE: FICO), whom he replacedLumen Technologies Inc. (NYSE: LUMN)when the upper limit of the latter's purchase fell below the inclusion threshold. If you've ever applied for a credit card or mortgage, you're probably familiar with Fair Isaac and its FICO scores. Here's a deeper look at the anatomy of the latest S&P 500 company.

What do S&P 500 stocks tell investors about the market? (1)Fair Issac has a market capitalization of just under $19 billion, placing it at the lower end of the index in terms of weight despite its high share price. The company does not pay a dividend, but averages more than 200,000 shares traded daily, and analysts rate the company a "moderate buy."

One of the reasons Fair Isaac was considered for inclusion is the stock's performance over the past 12 months, which has pushed the company's market capitalization above the eligibility threshold. A quick look atFICO Stock Chartshows that while many S&P 500 companies were paralyzed in 2022, Fair Isaac shares jumped more than 90%.

What do S&P 500 stocks tell investors about the market? (2)

What causes the meteoric rise in the share price? Many things can increase the price of a stock, but the usual reason is quality earnings andFICO earnings reportsfits that description recently. Investors are also expecting these earnings numbers to increase in 2023 and 2024. In their last report, FICO totaled $3.34 in earnings per share (EPS), and their 2024 forecast suggests that number will increase to $5.50 per share.

What is an S&P 500 index fund?

How can you buy exposure to the S&P 500? One of the most effective ways is index funds. Index funds are passively managed baskets of securities, such as mutual funds and exchange-traded funds (ETFs). But unlike active funds that hire managers to pick stocks, index funds try to mimic the performance of a basket of stocks in an existing index, such as the S&P 500 or the Russell 2000.

One of the main advantages of an S&P 500 index fund is the affordability it offers investors. Both mutual funds and ETFs that track the S&P 500 carry expenses of just a few basis points, such as the Fidelity 500 Index Fund (FXAIX, 0.015% expense ratio) and the Schwab S&P 500 Index Fund (SWPPX, 0.02% expense ratio). .

The first ETF ever to hit the market is, created in 1993 and currently has close to $400 billion in assets under management. SPY is one of the most popular assets on the stock market and it is not unusual for 100 million shares to change hands in a single session. SPY tracks the S&P 500 as closely as possible and owns all 503 stocks in the index. Since the Great Recession, investors who chose S&P index funds over DJIA funds have been rewarded.

What do S&P 500 stocks tell investors about the market? (3)

What is an S&P 500 ETF?

The best S&P 500 mutual funds aren't just mutual funds and ETFs with decades of experience. Many fund providers tweak the S&P 500 slightly for their own needs, either to increase exposure to certain sectors or to focus more on large orsmall cap stocks. For example,cuts S&P 500 stocks to 233 and focuses on companies with the greatest growth potential.

This ETF tends to grow, so of course the holdings are heavily focused on the technology sector. VOOG has 34% of itshares in technology stocksvs. SPY's 27%. And while growth funds have higher-than-average volatility, investing in the Vanguard S&P 500 Growth ETF has outperformed the main S&P 500 over the past five years.

What do S&P 500 stocks tell investors about the market? (4)

How to invest in the S&P 500

Want to learn how to buy S&P 500 stocks? First, you should familiarize yourself with ETFs and mutual funds as they are the best way to gain exposure to the index. Here's a quick three-step guide to building an S&P 500 investment.

Step 1: Develop an investment strategy.

First, you'll need to plan your investment and ask yourself a few questions about timeframes and risk tolerance. For example, are you investing long-term in a retirement account or in a short-term venture like a home down payment or vacation fund? Your investment goals will determine the type of S&P 500 assets you buy, so always review your plans before buying stocks.

Step 2: Select an asset class for exposure to the S&P 500.

Then choose the type of security you want for your investment in the S&P 500. If you're investing in a tax-advantaged retirement account such asyour IRA, you'll probably want to use mutual funds with low expense ratios. If you invest in a taxable brokerage account, consider an index ETF to avoid capital gains distributions.

Once you know what to buy, buy your shares in the desired investment account and follow the previously devised plan. Most investors use the S&P 500 as a long-term trade, as the index is constantly updated to include the best and most promising US-based companies. If you want to take on more risk, consider thematic ETFs such as the Vanguard S&P 500 Growth Index ETF.

The S&P 500 offers a variety of investment opportunities

The S&P 500 is one of the most important stock market indexes that tracks the performance of the 500 most important public companies based in the USA. And while the index doesn't always match economic growth step by step, it's used as a gauge of the health of the broader US economy. The S&P 500 can be invested through many different securities, such asETF, mutual funds, and even derivatives like options and futures. Regardless of your strategy or time frame, the S&P 500 likely plays an important role in your decision-making. You will always want to stay on top of the companies on this index.

Frequently asked questions

Here are some frequently asked questions about investing in the S&P 500.

What is the best way to buy the S&P 500?

The best way to buy the S&P 500 depends on your risk tolerance and preferred account type. Most investors choose between ETFs and mutual funds when considering exposure to the S&P 500.

Can I buy $100 of the S&P 500?

You can buy a share of an S&P 500 mutual fund for under $100, or use a brokerage firm with several stocks and buy a $100 preferred S&P 500 ETF.

How should a beginner invest in the S&P 500?

ETFs and mutual funds are the best S&P 500 investment vehicles for beginners. Pay attention to expense ratios to pay less for a simple index fund.

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